Tuesday, October 26, 2010

Q&A Series – College Savings Plans

This week's question comes from Lynn, a young mom who is wondering about 529 plans for her son's college education.

Q: Everyone keeps telling me that my son will be heading off to college before I know it. Considering how fast his first two years have flown by, I can see that this will be true. You seem to recommend that parents open 529 plans to save for a child's college education. What makes them such a wise option compared to other college savings plans?

A: If there's one topic we're asked about most frequently, it's 529 plans. It's true that we encourage people to save for a child's college education by opening 529 accounts.  They are tremendously powerful savings tools, and if you are going to save and invest for your child's education, then a 529 plan is the best tax-advantaged way to do so.  

529 plans are college savings accounts wherein the investment income not only grows tax-free, but can also be withdrawn tax-free when used for qualified post-secondary educational expenses. These expenses include tuition, room and board, books and supplies, computers and Internet access, and the funds cannot be used for primary or secondary education. Couples can contribute up to $130,000 over five years ($65,000 for single parents) without generating gift taxes, and some states allow up to $300,000 in total. We believe that it is appropriate to have a minimum goal of $100,000 in a 529 plan to adequately provide for a child's college education. 

Another benefit of 529 plans is that the assets are considered to be the parents', not the child's. This is usually more advantageous than just keeping the money in your name. It also makes qualifying for financial aid a little easier than if the assets were held in a custodial account in the child's name since a child's assets are more heavily weighed when financial aid decisions are made.

Moreover, if a child doesn't use the assets from their 529 plan, those assets can simply be transferred to other children -- even if they are not related -- without incurring a penalty. And anyone -- whether it is the child's grandma, grandpa, aunt, uncle or a non-relative like a close friend or godparent -- can open a 529 for a child.

We believe that the best way to fund a 529 plan is by making electronic transfers directly from your checking account into the 529 plan (Rollins Financial can set up an electronic transfer for you at no cost).  If you opened a 529 plan when a child is born and electronically transferred just $100 into that child's 529 plan each month, then by the time the child turns 18, you will have accumulated $38,929 in the account (assuming a 6% interest rate).  At $200 per month, you will have accumulated $77,858, and at $300 per month, you will have accumulated $116,787 by age 18.  

Most people reading this post can likely afford some level of contribution for a child's education, but since relatives and non-relatives alike are also able to contribute to 529 plans, perhaps you will be lucky enough to receive some assistance in meeting this important financial goal.  Even if a child's grandparents are not alive at the time he or she enters college, there could be no greater tangible gift than assisting in financing a grandchild's education.

There are two types of 529 plans: "prepaid" or "savings" accounts. The advantage of prepaid plans is that you can pay a child's future tuition at today's rates; the disadvantage is that prepaying a plan will likely lock you into a state's or a specific college's higher education system.  Some states, but not all, do allow for refunds plus interest if the child changes his or her mind. Also, prepaid plans often don't cover secondary expenses like computers and Internet charges -- indisputably necessary tools for college classes -- and plan administrators invest all of the assets.

On the other hand, 529 savings plans are much more flexible. Simply put, you choose how to invest the assets from selected options. At the time the child enters college, you use the account to pay for his or her higher education. In all instances concerning 529s, the institution must be an accredited college or university. Also, the assets must be professionally managed, and depending on the plan, participants can choose from up to 30 mutual fund-type investments that can be changed once every 12 months.

Another type of college savings plan is the Coverdell Education Savings Account (ESA). In this type of account, the distributions are tax-free, you can invest the funds however you wish without using a money manager, and the funds can be used for primary, secondary and post-secondary education expenses. Unfortunately, contributions are limited to $2,000 per student per year; contributors earning more than $110,000 (single filers) or $220,000 (joint filers) do not qualify; the contributions are not tax deductible, and; the assets are considered in the financial aid calculation since they are considered to be an asset of the child. In our opinion, Coverdell ESAs are inferior to 529 savings plans.

Like any investment, 529 plans do have their risks, and it is possible to lose money by investing in one of these plans. However, we don't think the risks are great enough to avoid dipping your toes into these investment waters. Rather, we suggest that -- if your children are young and unless your child is due to begin college next fall -- you should dive in to this typically rewarding college investment plan option.

Obviously, all college savings plans are not created equal. It's imperative that you sit down with an investment advisor to evaluate your objectives, the types of investments offered, and any plan expenses before making your decision.

Lynn, we hope we have provided you with some useful information regarding 529 plans. If you would like for us to take an in-depth look at your particular situation, Rollins Financial's investment advisors are always available.

We encourage our clients and readers to send us questions for our Q&A series at contact@rollinsfinancial.com. And as always, we hope you will keep Rollins Financial in mind when seeking professional advice on financial planning and investing.

Best regards,
Joe Rollins

Thursday, October 21, 2010

Q&A Series – Health Savings Accounts and Flexible-Spending Accounts

This week’s questions come from Ken, a client who is interested in learning more about Health Savings Accounts (HSAs) and Flexible-Spending Accounts (FSAs).

Q: Please explain Health Savings and Flex-Spending Accounts.

Open enrollment time and health-care reform have caused many folks to take a look at HSAs and FSAs and see if they might be a good option for their particular situations.

So, what are these accounts, and what are their advantages and disadvantages? A Health Savings Account (HSA) is just that – a savings account established by individuals and employers wherein the money contributed is used for medical purposes. HSAs are advantageous because the funds are not subject to federal taxes when deposited and the contributions are tax deductible (up to the maximum contribution amount set each year and only if you are not enrolled in Medicare Part A or Part B). Furthermore, the contributed funds grow tax-free and the withdrawals utilized for qualifying medical expenses are also tax-free.

HSAs are especially attractive because the funds roll over from year to year, meaning that whatever funds you don’t withdraw from the account can build over time. You are also not mandated to seek reimbursement for your medical costs from your HSA each year. Therefore, instead of turning in your minor expenses for reimbursement from your HSA, you can continue growing the account so that you will be in a better position to pay for any expensive medical costs that arise down the road. Additionally, like an IRA, you can invest your HSA money in stocks, mutual funds and bonds, which provides for further tax-free growth potential for use specifically on health expenses.

The theory is that when you pay your own medical costs, it makes you use medical services less (which is a good thing). Proponents believe that HSAs are important to reducing the overall cost of health care and making the health care system run more efficiently.

It’s important to keep in mind that you can only qualify for an HSA if you have a health insurance plan – specifically, a High Deductible Health Plan (HDHP). HDHPs have low monthly premiums, but cost more in out-of-pocket expenses. However, these expenses can be paid for with your HSA. The deductible must be at least $1,200 for single coverage or $2,400 for family coverage to qualify.

Flexible Spending Accounts (FSAs) are offered by employers to assist employees in saving a percentage of their earnings on a pre-tax basis to pay for medical and dependent care expenses, reducing the amount of the employee’s income that is subject to tax. The dependent care portion of FSAs is invaluable, as it helps subsidize child care costs for working families up to a maximum of $5,000 per year, tax-free.

FSAs are different from HSAs in that you don’t need to be covered by an insurance plan in order to have an FSA. You also must spend all of the money you have contributed within the coverage year, as whatever remains at year-end is forfeited. In other words, you must “use it or lose it.”

Basically, the employee calculates his or her medical and dependent care out-of-pocket expenses for the year to determine how much they want withheld from each paycheck (the figure should be fairly conservative to avoid any potential forfeitures at year-end). The employer holds these savings in a special account and, as the employee incurs medical and dependent care expenses, he or she submits to the employer the provider’s invoice along with proof of payment. The employer then issues a reimbursement check to the employee out of the special account. Easy peasy, right?

Q: Can you have both?

In general, no. But in particular situations – like if your FSA is limited to preventive care, vision or dental (“limited purpose”), or only pays for medical expenses after the HDHP deductible is met (“post-deductible”) – then you may still be eligible for an HSA. Furthermore, if your spouse has an FSA or HSA through his or her employer that pays any of your expenses before your HDHP deductible is met, then you cannot have an HSA.

Q: What will the new limits be?

The health-care reform bill actually made very little changes to HSAs, the biggest being the increase in penalty from 10% to 20% for withdrawing the money for nonmedical expenses before age 65 which will take effect in 2011. Also, beginning in 2011, over the counter drugs that are not prescribed by a doctor – except for insulin – are not reimbursable expenses under HSAs or FSAs.

By far, the biggest change concerns the maximum allowable contribution to FSAs. In years past, there was no maximum contribution amount for the medical portion of FSAs (although most firms capped contributions at $5,000 per year). Beginning in 2013, however, annual FSA contributions for medical expenses will be limited to $2,500 per year, making them less appealing. Contributions for dependent care expenses under FSAs will remain capped at $5,000.

On the other hand, HSA contributions will continue to be determined by the cost of living. For 2011, individuals with employee-only coverage can contribute up to $3,050 while those with family coverage can contribute up to $6,050. If you’re 55 or older, you can also make a $1,000 catch-up contribution. Furthermore, the maximum reimbursement amount for 2011 under HSAs, including deductibles, will be $5,950 for single coverage and $11,900 for family coverage.

Ken, I hope my answers above have given you and our other readers some insight regarding HSAs and FSAs. There are pros and cons to each type of account, and therefore, it’s important to assess your health and financial circumstances to determine if one or the other – or both, in limited circumstances – is appropriate for you.

We encourage our clients and readers to send us questions for our Q&A series at contact@rollinsfinancial.com. And as always, we hope you will keep Rollins Financial in mind when seeking professional advice on financial planning and investing.

Best regards,
Joe Rollins

Tuesday, October 19, 2010

Congratulations Josh!

From the Desk of Joe Rollins

I am excited to report that my son, Josh, celebrated his most recent golf victory this past weekend at the Druid Hills Junior Championship, winning the tournament with an incredible two-day score of 147. Congratulations, Josh!

On Saturday, Josh had five three-putt greens, but still had a fairly consistent round, scoring 75 for the day. On Sunday, Josh’s momentum picked up and his game really started to excel. He shot a 32 on the front nine – four under par –and 40 on the back for an incredible score of 72 (including one Eagle) for Sunday. His nearest competitor at Druid Hills was Mitch Fenbert, who is one of Josh’s closest friends. Mitch also played great at the tournament, shooting 151, just four strokes behind Josh.

With this most recent victory, Josh has now swept the two junior championships that he has competed in this year. Earlier, Josh won the Ansley Junior Championship (see the post here), and has now added the Druid Hills Junior Championship to his golf accomplishments.

Someone asked me this morning if I attributed any of Josh’s success in golf to my training. Given that I have only broken 80 one time in my illustrious career, I think Josh has far exceeded my golfing ability. Additionally, only a few years ago I was trying to keep Josh from making sand angels in the sand traps during our rounds. It’s amazing how fast kids grow up!

Well done, Josh! I am very proud of you.

Sunday, October 17, 2010

News - October 2010

How low can you go? Bond yields are doing their own version of the limbo as the Federal Reserve threatens another round of quantitative easing; and, for now, prospects for widespread inflation seem muted. In general, “quantitative easing” (QE) is the buying of mostly government- and mortgage-backed bonds by the Federal Reserve in order to influence interest rates lower. The Bank of Japan has even gone a step further and announced their intention to not only buy government fixed income securities, but to also buy privately issued assets like corporate bonds, exchange traded funds, and real estate investment trusts.

The 10-year treasury yield is hovering around 2.5% after rising as high as 4% earlier in 2010. Low rates are typically an indication of low future economic growth, or very low expected future inflation, or a combination. Clearly, the QE is playing into rates also and it’s greatly debatable as to how much of the recent drop in interest rates is attributable to the Fed’s actions, inflation expectations and economic expectations. Some have argued for some time that the various fiscal and monetary stimulus programs are a prelude to significant inflation down the road. But the bond market doesn’t seem to be corroborating that popular thesis, even in light of slightly higher rates in recent days.

Falling bond yields continue to be a boon for investors holding fixed income securities. The BarCap Aggregate Bond Index has advanced 7.9% for 2010 through September 30th. Earlier this year, Bill Gross, the famed bond investor, seemed to indicate that the bond bull market of the past 30 years was drawing to an end and predicted rates would move higher. Six months after Mr. Gross made his prediction, all signs are pointing to the great bond bull market stretching for at least 31 years.

Stocks rose dramatically during the month of September. Fresh off a downdraft in August, markets have alternated between positive and negative monthly returns for the past several months. Stocks advanced during the third quarter just as the chorus for a possible double-dip began to grow a little louder. That song has been quieted a bit for now.

The widely followed Dow Industrial Average is within earshot of the 11,000 mark again after advancing 7.9% for the month and 5.6% for 2010. The S&P 500 is now positive by 3.9% through September 30th for all of 2010 after an 8.9% advance just for the month of September. Small cap stocks outpaced the large cap indexes during September, rising 12.4%, and have gained 9.1% YTD through September 30th.

Developed international stocks posted a strong September as well, rising 9.8% for the month to just barely enter positive territory for the year at positive 1.1%. Emerging markets have fared better than other international investments, advancing 11.2% for the month of September, and have logged a gain of 10.6% for the year. We are seeing some wide discrepancies regarding emerging stock market returns this year as India has far outpaced the gains of its BRIC brethren.

Real estate investments have been the top performer all year despite continued softness in the housing market. Through September 30th, real estate has gained 18.8% for the year, although the category is showing some signs of weakness as the broader stock market gains over the past month have significantly outperformed this sector. REITs are a diverse group as some specialize in apartment housing, operating shopping malls, or commercial real estate, for example.

Gold has continued its decade long run this year. The precious metal has advanced 18% for 2010 as of September 30th. While gold is generally thought of as an inflation hedge, other indicators seem to be flashing muted inflation for some time to come. Long-term U.S. Treasury bond yields have fallen significantly since earlier this year.

Conversely, Financials and Energy/Natural resource stocks have lagged the broader market in 2010. For financial stocks there has been yet another renewed concern over foreclosures and their impact on bank stocks. Clearly the system is not built to process the current massive number of foreclosures and financial institutions are having difficult time adjusting. A recent characterization attributed recent problems to the contrast between our complex system of securitizing mortgage debt with antiquated property laws.

The final employment report before the midterm elections was released and the results were mixed at best. According to the Labor Department, the economy lost 95,000 jobs during the month of September. Private sectors actually added jobs again, although less than the prior month and not enough to bring down the unemployment rate. Governments shed both temporary and permanent positions which overwhelmed the overall jobs picture.

It seems we are in a perpetual “wait and see” mode with this economic recovery. We observe many crosscurrents in the various financial markets and economic indicators. Stock prices have moved higher as corporations have become healthier, leaner and more profitable, but housing prices have only stabilized at best. The economy has stopped shedding jobs, but has not yet starting producing enough jobs to bring down unemployment and increase confidence. Commodity prices are indicating higher inflation and demand, while bond markets suggest the opposite.

To be sure, we are facing an uncertain future, but that has probably been the case and an asset for investors during most of our history. Certainty in the success of investing in stocks or the success in our real estate purchases has almost always been a precursor to a serious correction if not outright collapse in prices. So, uncertainty is good in that it suppresses current asset prices and very well may imply better future returns on those assets than we expect. We hear much about the “certainty” the election in a few weeks will bring. We suppose that elusive state of “certainty” may persist for a couple months perhaps, just until our focus is trained on the next election.

Saturday, October 16, 2010

Why Is Everyone So Jumpy?

From the Desk of Joe Rollins

As I’ve said before, the general public’s fearfulness that the economy is falling back into recession is baffling. I have seen no economic evidence to support that fear, and why the anxiety continues accelerating is a mystery to me. In fact, there is overwhelmingly good news about the economy. Clearly, investor anxiety is running amok.

In a recent New York Times blog post, "The Recession Has (Officially) Ended," it was stated that a vast majority of U.S. investors have abandoned investing altogether. I suppose that just goes to show that small investors tend to do exactly the wrong thing – invest when the market is at a high, stick around long enough for their portfolios to go down, sell out at the bottom and then never reinvest. Small investors who have not reinvested since March of 2009 have missed a cool 85% increase in the stock market.

Through Thursday, October 14, 2010, the S&P 500 Index was up 6.8%. Through the same time frame, Rollins Financial’s total portfolio under management is up an even more impressive 9.84%. Therefore, through the first 10 and a half months of 2010, our managed accounts are outperforming the S&P 500 by approximately 44%.

If asked how the stock market has been doing for 2010, most people would likely tell you that it continues to lose money. My guess is that these are small investors, and as I stated above, they are usually wrong.

The following are some positive attributes for the stock market going forward:
  • First and foremost, it was recently announced that the recession ended in June of 2009, almost 15 months ago.
  • Interest rates are extraordinarily low. Furthermore, the 30-year home mortgage interest rate has fallen to its lowest level ever. Earlier this week, you could obtain a 30-year fixed mortgage at a rate of 4.18%. Long-term interest rates have never been this low in the history of the United States. If you have not refinanced your mortgage to get this low rate, you are giving up one of the greatest all-time government subsidies.
  • Even though we’re in the early stages of reporting earnings for the 3rd quarter of 2010, the earnings that have been reported are nothing short of breathtaking. Corporate earnings will be the highest ever recorded in American finance next quarter. Why? Because corporate America is operating more efficiently with less overhead and less administrative costs than in its entire history.
  • Corporate America is sitting on a cash balance of nearly $1.8 trillion. When business finally improves, you may rest assured that corporate America will allocate these assets to higher earning investments. Corporate America cannot sit on this high level of cash balances when it earns next to nothing. Corporate America will soon use this cash to buy other companies or make investments that pay many times the rate of cash. The only thing necessary for these businesses to allocate capital is to develop some level of confidence.
  • U.S. investors are saving and paying down debt at unprecedented levels. The American consumer is finally deleveraging himself. For the first time in over a decade, American consumers are saving more and using their significant cash flow to pay down debt. While these actions are a short-term drain on investing, they are very much a long-term positive for the American consumer. Even this morning, retail sales for September reported a strong 0.6%. August retail sales have been revised up to 0.7%. Retail sales would not be increasing unless the consumer was starting to feel a little more confident about their job situation.
  • It was announced this week that the infamous Troubled Asset Relief Program (TARP) could potentially make money. It’s currently projected to lose about $18 million, but if the car companies are able to complete an initial public offering, there is a chance the TARP will show a profit. You may recall that when the $787 billion TARP was proposed, it was considered to be a complete waste of money that would be totally lost by the U.S. government. There weren’t many who thought it would ever break even, but I am one of the few who did believe that investing in American banks would be profitable. Don’t believe me? Read my September 24, 2008 blog - "This is Not a Bailout!" It’s rewarding to be proven correct when so many economists argued that the entire amount would be lost and wouldn’t help the economy anyway.
  • The Federal Reserve Bank of New York released its Empire State Manufacturing Survey this morning. It was expected to be in the 3% to 6% range, but came in at the breathtaking rate at 15.73%.
  • In recent weeks, the U.S. dollar has fallen off a cliff and gone down in value. While that may sound like a negative, it’s actually very much a positive. When the dollar is low, U.S. companies compete in international commerce by exporting more. As we manufacture to export more, this creates jobs and a better U.S. economy.
  • The mid-term elections will likely create complete gridlock in Washington, which is usually a plus for the stock market. From the polls, it appears that the Republicans will take over the House by several positions and the Senate race will be a dead heat, although it doesn’t appear that the Democrats will lose control of the Senate. As far as I can remember, the best investing years were from 1994 through 2000. During that timeframe, Bill Clinton (a Democrat) was in office, but almost nothing could get through the Republican-controlled Congress. Gridlock in Washington is as good as it gets for investing. Come November, we are almost guaranteed total political gridlock. Since it will be almost impossible to get anything accomplished, perhaps both the House and the Senate should just take a two-year vacation.
There may be negatives in our economy affecting investing, but they are few in comparison to the positives listed above. A few of the negatives affecting the economy that could impact the stock market are as follows:
  • Unemployment continues to be stubbornly high. Even though the economy has clearly recovered, unemployment rates are not going down anytime soon. Until there is a higher level of business confidence, you will not see employers hiring the many people who are out of work. While it is unfortunate that unemployment is at 9.6%, it appears that the 90.4% who are employed are spending more and feeling better about the economy, thus, increasing retail sales.
  • The federal deficits, over the short-term, are not really a problem, but they can become a long-term disaster if allowed to continue. Based on Washington’s current projections, the deficit could approach $10 trillion over the remainder of this decade. Clearly, the public has spoken and the trend is changing in Washington. I expect a new attitude in Washington regarding deficit spending, and hopefully, there will be a long-term plan initiated. The budget doesn’t need to be balanced, but a plan does need to be created to work toward balancing the budget. It’s interesting to see Great Britain actually cutting their government expenditures by 25% in one year alone. Perhaps Great Britain will be an example of what we should and could do in the United States. However bad the deficits appear to be now, it appears that there will be a new sheriff in town in November, which will hopefully help us get back to some sense of normalcy.
A client told me the other day that the increase in the stock market was really a house of cards. Given that this client makes his living in commercial real estate, I can understand his skepticism. While there are certain pockets of our economy that are in desperate straits, it’s quite unusual to see such skepticism by the general population while corporate profits are at historic highs. Hopefully, if you avoid the “gloom and doom” reported by the media and instead review the facts regarding the economy, you will see that while the economy isn’t great, it is on solid footing.

Something that has clearly been missed in this stock market rally is that extraordinarily high profits and low interest rates make stock investing much more desirable. I see nothing on the horizon that would change any of those thoughts regarding investing.

Speaking of investing, have you made your IRA contributions for 2010 yet?

As always, the foregoing are my opinions, assumptions and forecasts. It is perfectly possible that I am wrong.

Tuesday, October 12, 2010

Tuesday Q&A Series – Investments Outside Rollins

This week’s question comes from Kelly who is 48 and a Rollins Financial client. She has questions regarding her investments outside of her current accounts at Rollins Financial.

Q. I enjoy knowing that someone is looking after my accounts and being able to call with questions/concerns about them. One question is can you handle my current retirement account (401k) with my employer for me? I would like to know it is being handled in the same manner.

This is a very good question and one that we are frequently asked. It is always good for our clients that we know and understand what is going on in your accounts held outside of Rollins Financial. This allows us to make sure that you are diversified accordingly, and to give advice on changes that should possibly be made to benefit you.

Unfortunately, we can only determine whether we can actually manage the outside accounts on individual basis.

Through Fidelity (which is the largest 401(k) provider), we have the ability to directly manage some 401(k) accounts through a service called “BrokerageLink.” If your 401(k) plan is at Fidelity, this could be the way to go. 

If your retirement account (401k, 403b, etc.) is held elsewhere, we can definitely help you review the options and the accounts at the very least, and we still may be able to manage the funds. In any case, we will obviously help point you in the right direction on investment options and contributions.

**Note** - If you have left a previous employer, remember to rollover your old retirement accounts. The process is quick and painless, and it insures that your retirement accounts are working for you and not just sitting idle paying fees for your old account.

Q. I inherited some old stock certificates from my relatives. What should I do with them?

This is something that we run across quite often and is always a good question. The best thing to do is to put the certificates in your account for many reasons.

First, from a “safekeeping” perspective, putting the certificate into your account guarantees that it is secure. We have seen numerous individuals lose stock certificates over the years through fire, theft, or just being misplaced. When this happens, the transfer agent (company responsible for handling certificates) must be contacted and the shares must be replaced. This sounds simple, but there is a standard fee of 2-3% of the value of the certificate. If the certificate is worth $100,000, you are now paying $2,000 - $3,000 for its replacement. Writing a check to pay a fee for a lost stock certificate usually wakes people up rather quickly.

Second, from a tax perspective, the fewer the number of investment accounts you have; the less likely you are to make mistakes and omit something come tax time every year. Thus dividends or even selling the stock can cause problems later if you have not reported the transactions as required by the IRS. By placing the stocks in your current account, the dividends and transactions are included on the 1099's you get from Schwab/Fidelity. It is easier to call one place - Rollins Financial - to get the information come tax time than 10 different places.

Also, the stocks have a cost basis that will affect the tax ramifications of selling them. The sooner you receive help to determine the correct basis – whether purchased, gifted to you, or inherited – the easier it is to find the correct basis.

Finally, whether you intend on holding the shares forever or want to sell them to reinvest in other investments, we can help you make informed decisions regarding the stock.

**Note** - If you wish to just hold them, we can place them in an “unsupervised” status which essentially means that they are held in the account at the custodian, but Rollins Financial does not charge you for that stock(s). We do this as a courtesy service for our clients to help them consolidate their assets. If you have a question about utilizing this service for some old stock certificates, please let us know.

Kelly, I hope the answers above are helpful to you, and we certainly thank you for your questions and for being a client. We are always looking to help our clients make the best financial decisions possible with their investments at Rollins Financial and elsewhere.

We encourage our clients and readers to send us questions for our Tuesday Q&A series at contact@rollinsfinancial.com. And as always, we hope you will keep Rollins Financial in mind when seeking professional advice on financial planning and investing.

Best regards,
Robby Schultz

Monday, October 4, 2010

The Building Blocks for a Great Investment Year

From the Desk of Joe Rollins

As you may be aware, September is historically the worst investment month of the year. In fact, only September has the distinct – and not exactly coveted – record of being the only month that has an average negative return. As we entered the month, the financial press proclaimed that we were headed for an even bumpier ride than usual during September. However, this past September actually defied the odds and wound up being an excellent month for investors.

For September of 2010, the S&P 500 was up 8.9%. For the year through September 30th, the S&P was up 3.9%. The Dow Jones Industrial Average’s performance was even better, as it was up 7.9% for the month of September, while being up 5.6% for the year through September 30th. Fortunately, Rollins Financial’s total assets under management also reflect impressive returns. For the year through September 30th, our total assets under management have had a return of 7.1%, which means that our returns have exceeded the S&P 500 return by a stunning 82%. For the third quarter of 2010, Rollins Financial’s assets under management had a total return of 10.43%.

While most investors may not consider a 7.1% return to be robust, it can be put in perspective by comparing it to historic results for the financial markets and considering the miniscule yields currently available on interest paying investments. For example, a risk-free, two-year Treasury currently yields a rate of 0.41%. That means for every $100 invested, you will earn $0.41 for the year. Furthermore, you would need to hold that two-year Treasury bond for a total of 17.5 years to have a gain of 7%, the return earned by Rollins Financial during the first nine months of 2010.

I am completely baffled by investors who instead of investing in the stock market are willing to accept interest rate returns that are so low they could almost be considered a rounding error. For example, we received instructions this week from a client to put a significant portion of his investment portfolio in money market rates. At the current time, money markets are paying virtually nothing since the earnings are hardly enough to even pay the management fees.

For an interesting perspective on interest rates, I suggest you read Charles Schwab’s editorial published in The Wall Street Journal on Saturday, October 2nd - Enough With the Low Interest Rates! Nothing could be clearer to the average investor that low interest rates are hurting the investment results for all Americans who rely on fixed rate investments for retirement income.

As an investment advisor, I find this apprehension to be even more baffling when major U.S. corporations are paying significant dividends that are well in excess of the amounts earned by investing in interest paying certificates. For example, the dividend rate on major corporations such as Chevron (3.5%), AT&T (5.8%), Verizon (5.9%), Johnson & Johnson (3.5%), and General Electric (2.9%) far exceed any type of interest rate that you can earn on a risk-free investment; plus, you have the opportunity for capital appreciation.

So far, 2010 has felt like a roller coaster ride for many investors. Through June 30, 2010, the S&P 500 was down 6.7%. For the month of July, the index rebounded handsomely at 7% only to fall 4.5% in August. Therefore, the first six months of the year were down, July was up, August was down and September was up. Volatility is definitely present in the financial markets. However, as we have often pointed out, an investor shouldn’t be concerned with daily or weekly returns. Rather, investors should be focused on long-term returns, which have been excellent.

Clients continue to ask me how stock market performance can be so good given the negative nature of the U.S. economy. A great deal of the ongoing conversation regarding the economy is mischaracterized by the financial press. I am not sure that this mischaracterization isn’t politically motivated given the mid-term Congressional elections scheduled to take place next month.

While it can’t be said that the economy is great right now, it is perfectly okay. The second quarter GDP was up 1.7% and we discovered during September that the recession officially ended over one year ago in June of 2009. Furthermore, it is anticipated that the GDP for the third quarter of 2010 will be approximately 2%. While this certainly isn’t vigorous, it is still positive and the economy is stable.

Given the extraordinarily low interest rates that are available on interest-earning certificates, along with the extremely high profits being enjoyed by major corporations, there is ample reason for the stock market to move even higher.

There are many contradictions in the financial press due to the political biases of the newspaper publications printing articles. For instance, The Wall Street Journal, which is known for its politically conservative views, has been critical of President Obama’s moves to improve the economy. In an article in Monday’s edition of the WSJ ("Propelling the Profit Comeback"), the increased profitability by American corporations – the most important component to higher stock prices – is discussed. The article reports that the U.S. Commerce Department estimates that the second quarter after-tax profits rose to an annual rate of $1.208 trillion, up 3.9% since the first quarter, and up 26.5% since the first quarter of 2009. If you need any other reason for stock prices to be up, this is it.

The estimated profits for the second quarter of 2010 is the highest rate of profitability ever in the history of American finance. Even if you adjusted this figure to accommodate for the percentage of national income, it is still the third highest since 1947 -- exceeded only by two quarters during 2006 in the course of the economic expansion.

Ironically, the reason for these extraordinary profits is the very thing that is holding the U.S. economy down – an accumulation of cash by U.S. corporations that are not hiring due to the uncertainty of the fragile recovery. What U.S. corporations need to expand their workforce is a better economic outlook for the U.S. economy and some sort of confidence in the regulations coming out of Washington. You may rest assured that all U.S. corporations would increase employment and expand their operations if there was a demand for their products. Even though the economy has recovered, it is not as strong as investors would like it to be.

In contrast, "Cheap Debt" was published on the front page of Monday’s edition of the New York Times. The NYT is known for its progressive approach regarding economic matters, and American corporations appear to be demonized in recent articles. The NYT seems to indicate that U.S. corporations have a moral obligation to increase employment. In this particular article, it is implied that with interest rates so low in the current marketplace, major U.S. corporations are borrowing billions of billions of new debt at miniscule interest rates without increasing employment. The reporter correctly points out that U.S. corporations have accumulated close to $1.6 trillion in cash – the highest ever recorded – but have not increased employment or built news plants or equipment.

The NYT article also reports that Microsoft is one of the most profitable corporations in U.S. finance (perhaps even the most profitable in U.S. finance history outside of the oil industry). Microsoft reportedly recently borrowed a significant amount of money in the open market on a three-year debt offering of 0.875%. Given that they could invest this money at approximately 2.6% in a 10-year Treasury, you can see the spread in interest rates, which earns them significant profits. However, Microsoft apparently has no intention of increasing employment or expanding their plant or equipment.

Even more remarkable is the long-term borrowing by corporations less financially sound than Microsoft. For example, Norfolk Southern Corporation recently borrowed $250 million in 100-year bonds at an annual rate of 5.95%. Basically, they borrowed at 6% per year for a century. Those types of long-term interest rates are rare, indeed.

The one thing the WSJ and the NYT articles agree on is that corporate profitability is extraordinarily high. Again, stock prices are influenced the most by high profitability. As I pointed out in my August 2nd post - "Whoops, Did I really read that in America?" - I believe that U.S. corporations have no obligation to hire when they do not need the personnel. Once again, it appears that the NYT and I must agree to disagree on this subject.

In any case, corporate profitability continues to be excellent, interest rates continue to be low and the U.S. economy continues to improve. Given that excellent investment criteria, I do not expect anything other than additional profits in investing in the upcoming 12 months.

As always, the foregoing are my opinions, assumptions and forecasts. It is perfectly possible that I am wrong.